POB advisory panel recommends ways to bolster independent audits.

An advisory panel appointed by the Public Oversight Board (POB) of the SEC practice section of the American Institute of CPAs division for CPA firms published a report recommending ways to enhance the integrity and objectivity of independent auditors. The report, Strengthening the Professionalism of the Independent Auditor, is a comprehensive study based on prior studies and reports, solicited written comments and extensive interviews with professionals in practice and academia. Making up the advisory panel were Donald J. Kirk, former Financial Accounting Standards Board chairman, George D. Anderson, past AICPA board chairman, and Ralph S. Saul, formerly president of the American Stock Exchange and past director of the Securities and Exchange Commission Trading and Markets Division.

The panel's appointment was prompted by recent public skepticism about the objectivity of the profession and remarks by Walter P. Schuetze, SEC chief accountant, who said auditors were unduly influenced by client views in formulating positions on FASB proposals (see "Schuetze Wary Over CPA Independence on Stock Option Proposal," JofA, Mar.94, page 9).

The advisory panel identified ways to enhance auditors' professionalism and to improve the working relationships between the profession, the SEC and the FASB. Curtis C. Verschoor, senior research professor at DePaul University's School of Accountancy in Chicago, said, "The POB study should alert the profession to the critical need for far-reaching steps to regain public confidence."

Corporate takeovers and business failures of the 1980s gave rise to more powerful corporate boards of directors, says the report, increasing large institutional shareholders' recognition of the boards' obligation as their elected representatives. The report urges the POB, the SEC and others to enhance boards' independence and their accountability to shareholders. "Stronger, more accountable boards," says the report, "will strengthen the professionalism of the outside auditor."

Most of the principal recommendations focus on the relationship between the, independent auditor and the corporate board of directors. It is essential, says the report, to clarify who the auditor's client is. "The board of directors," says the report, "as the representative of the shareholders, should be the client, not corporate management." The panel advises boards to view independent auditors as "natural allies" in protecting shareholder interests.

The report says independent judgments can be inhibited when the relationship between the auditor and management is too close. "Shareholders and boards," says the report, "should expect auditors to challenge management's views on accounting principles, disclosure practices and accounting estimates and to inform the board about how shareholders' interests are affected by management's accounting choices within the range of acceptable practice."

The report also recommends auditors offer audit committees and boards of directors qualitative judgments about management's choices of accounting principles, disclosures and estimates. The panel is holding auditors to a new standard in communicating with boards, calling for open dialogue regarding particular choices made within the range of acceptable practice.

Addressing large CPA firms' senior management, the report says organization structures and business strategies may require more attention at large CPA firms for which auditing is one of many lines of business. However, Verschoor said there was a lack of "any specific recommendations for dealing with" this situation.

The speech by the SEC chief accountant and actions by the large CPA firms in connection with the FASB's project on accounting for stock-based compensation are evidence of the poor relationship between the public accounting profession, the standard setters and the SEC. The report says these three groups, which share common objectives with respect to the public interest, must "communicate, treat each other with respect and cooperate in the standard-setting process."

The report says the panel found no need for the SEC or the AICPA to add to or amend existing regulations relating to auditor conflicts of interest. The report emphasizes, however, the ongoing need to keep current rules and regulations up-to-date to reflect changes in the business environment.

Citing litigation's "damaging and costly" impact on the profession, the report calls on the SEC to "take the lead" in reducing the profession's exposure to unwarranted litigation. It says that although tort reform is necessary, it alone will not be enough to enhance the "integrity, objectivity and professionalism of the independent auditing function." The report says a better legal environment would "encourage the profession to analyze and learn from audit failures."

Copies of the report are available by calling the POB at [phone].